Thursday, July 31, 2008

We Are Selling Our Vacation Home … Can We Do A 1031 Tax Deferred Exchange?

Until March of this year vacation homes had a weird non-status … they weren’t investment property and they weren’t personal use property in the eyes of the IRS. To achieve a 1031 Exchange the property must be held for investment or used in a trade or business. After a U.S. Tax Court disallowed a taxpayer’s exchange from one vacation home to another the IRS recognized that some guidelines were needed to establish what could be done to qualify a vacation home for a 1031 Exchange.

The result is a Revenue Procedure ruling that was effective March 10, 2008, the first IRS guidance on the matter since a 1981 letter. The Procedure ruling provides guidelines that the IRS says, if followed, they promise not to challenge the investment nature of your vacation home.

The ruling requires that you hold the relinquished property at least 24 months if it is your vacation home or the acquisition property for 24 months if you intend to buy a vacation home, or for both if you are moving from one vacation home to another. Note that this is more stringent than the one year holding period required for a safe long term capital gain status.

Additionally, for each twelve month block of the holding period you must rent the vacation home at least 14 days at a fair market rent. During that same period, you the owner, can only use the property for the greater of 14 days or 10 percent of the days rented. For instance, if you rented it for 30 days in a year your use is limited to 14 days, but if you rented it for 200 you could use it for 20 days. Days that relatives use the unit for free count against you. Not discussed, but generally understood, is your allowance for maintenance days. You are allowed a reasonable number of “maintenance days” to care for your unit, but don’t try to take a week shampooing the carpets.Our Advice: You now have specific qualifying criteria to meet that will allow you to rest easy knowing that your vacation home exchange will not be challenged. Understand that this is what is known as a “safe harbor”, guidelines that you and your accountant can use with confidence. If you don’t quite qualify it doesn’t mean the end of the world, but you might get looked at closer by the IRS. The best thing you can do is maintain excellent records, be serious in your rental attempts, charge family members market rate for their use, keep detailed records of the dates you use it and what you did, i.e. - maintenance days. Your records are very important for the ultimate success of your exchange.

Tax ramifications are an important component of the buy/sell decision in real estate. The 1031 tax-deferred exchange is designed to encourage the investor to keep his money invested. The ability to defer the tax obligation rather than paying for the taxes on the profit of each transaction along the way can have a significant beneficial impact on your portfolio as you create wealth via real estate. Work with your accountant and real estate agent to maximize your return and minimize your liability as you buy and sell real property.

Experience is Priceless Lisa Wetzel & Jim Valentine; RE/MAX Realty Affiliates, 775-781-5472 or toll free at 800-814-8799 ext. 254, email us at, or visit our website at .


William L. Exeter said...

Hi Lisa and Jim,

Great post. The majority of real estate investors or property owners do not realize that they can 1031 exchange vacation homes, especially given the new ruling. The more real estate owners know and understand about 1031 exchanges the better. Good job in keeping them updated.

Lisa Wetzel and Jim Valentine said...

William ... Thanks for your comment and interest!

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